Gavin A Wood, Emeritus Professor, Centre for Urban Research, RMIT University
Susan J Smith, Hon Emerita University Professor of Social and Economic Geography, and Life Fellow at Girton College, The University of Cambridge.
Introduction
The Australian Government has delivered a Budget that, finally, has addressed the taxation of housing investment returns to tackle a housing emergency that has been demanding attention for many years. These changes are modest, and ‘grandfathered’: they will limit negative gearing to new builds and abolish the 50% capital gains tax (CGT) discount. This latter will be replaced by inflation-adjusted cost base indexation with a minimum 30% tax rate on real capital gains. If these shifts seem radical to some, it is because of the obdurate resistance to any tax reform at all in this area.
Australia’s Housing System is blighted by severe housing affordability problems as house prices have outpaced wages, while private rents are out of reach for a growing number of low-income households. This is fueling economic inequality, as the divide between property owners and tenants widens. This polarisation is partly about growth in real house prices and stubbornly low levels of new housing supply, but it also reflects the emergence of a class of secondary property investors that are attracted by real estate tax concessions and the improved yields that PropTech is spawning. Meanwhile, social housing remains a residual sector in the Australian housing system, unable to meet the housing needs of those stuck on lengthy waiting lists, or the homeless. The housing crisis has reached an acute state that warrants reforms even bolder than those set out in the Budget.
Housing ‘Feebates’: A Proposal
We propose a comprehensive reform to the taxation of residential property in the interests of fairness overall, and with a view to raising the revenue needed to transform housing systems for the future. This proposal would absorb taxes levied conditional on transactions in housing (stamp duty and CGT) into a two-tier recurrent fee structured as a Land Value Tax (LVT) embracing existing state land tax arrangements. The new charge would apply both to primary properties (those owned and occupied by the same household) and secondary properties (with absentee owners). These private property owners will be required to register and pay an annual fee that is a fixed proportion of annually revalued land at appraised market values. Primary owners’ fees are calculated at a base rate, while those paid by secondary owners are calculated at a higher premium rate. This proposal sits aside from the taxation of landlords’ rental income streams, though the budget’s negative gearing proposals should—in the interests of fairness and the supply of capital to other sectors—be extended in a phased way to all rental investments.
The two-tier fee structure can be set at a level that simply replaces revenue from the abolished taxes. However, by applying it across all properties, it could, for a small uplift, also finance a social housing investment programme and yield a universal taxable dividend that is returned to all home occupiers as a modest annual lump-sum payment.
Practical and Political Hurdles
As with all meaningful fiscal reform, this package must overcome important barriers. There will be fears that reforms of this scale could destabilise housing markets if abruptly introduced. To counter these fears, a phased introduction of the reforms is judicious. This is evident in the Budget, where current arrangements generally remain in place for existing property owners. The new feebate arrangements could follow that lead, applying to future property acquisitions by either existing or new property owners. However, that could also introduce an unwelcome degree of stickiness in the market, so other styles of phasing could also be modelled. Any such phasing would also include eligibility for the annual housing dividend. That itself would act as a ‘carrot’ to existing property owners who might be tempted to hold on to properties, apprehensive about moves onto the new system, despite the removal of stamp duties and CGT.
It is likely to be politically palatable to sweep aside unpopular taxes linked to spending and hence income (stamp duty), or to the release of funds that boost income (capital gains tax). However, replacing these with an annual LVT, levied irrespective of the taxpayers’ income, might be less popular on the grounds that it would seem especially onerous for those who are asset-rich but income-poor. The phased introduction we envisage, of course, protects those in this group who have no intention to move. But there will be homeowners, particularly older retiree households, that may postpone plans to trade down because they are unable to meet the ongoing annual fees. A deferral scheme that assists these people is then critical. The most promising avenue here is an equity deferral programme. Tax collection agencies would register the unpaid annual LVT liability as a percentage of assessed land value, to be settled when the property is sold or transferred. It has similar attributes to a home equity insurance programme. In a rising market, previous years’ LVT liabilities will increase in line with assessed land values, but in a falling market, previous years’ liabilities will decline in line with assessed land values. It therefore eliminates the downside risk in falling markets.
Ideally, cadastral values for all residential land lots should be assessed at market values and updated on an annual basis. Arriving at separate valuations of land is an important challenge because most transactions exchange land-building packages. But in today’s world, extracting land values from property transactions is eased by big data sets, technologies that permit rapid data processing, and sophisticated hedonic statistical models. For a number of countries, including Denmark and Germany, these challenges have been surmounted.
Fairness and Efficiency Benefits
The potential benefits from reforming the fiscal treatment of housing in the way that we propose are unusual in that they combine efficiency gains with fairer outcomes, as well as simpler housing tax arrangements. Those fairer outcomes are due to an expansion of social housing funded by diverting part of the revenues from fees. The premium fee paid by secondary owners also create a more ‘level playing field’ for primary homeowners, including first-home buyers. This is especially important because, in recent times, we have witnessed a surge in tax-favoured investment demand from secondary property owners that is increasingly directed at short-term lets. With new supply lagging behind demand, prices have been pushed ever higher, crowding out first-home buyers and adding to the housing affordability problems of renters. A more level ‘playing field’ eases these pressures. Finally, the payment of a universal annual dividend that is part of assessable income is the equivalent of annual targeted tax cuts that could be the forerunner of a universal income programme further down the track. Its progressive incidence, as well as universality, could therefore encourage ‘buy-in’ from a public seemingly wary of ambitious reform.
Feebates replace taxes that are widely regarded as inefficient, especially stamp duties, which impede residential mobility and thereby contribute to mismatches between housing currently occupied and that preferred. Labour mobility is also negatively impacted, as stamp duties add to the transaction costs associated with moves necessary to take advantage of new job opportunities. As a result, job vacancies can be more difficult to fill, or filled at the expense of longer commutes, with productivity losses a by-product.
Capital gains taxes are also problematic. Ideally, accrued capital gains from all assets would be included in assessable income for income tax purposes. But tax is in fact levied when gains are realised, not when they accrue, and gains on primary residences are exempt. On CGT-eligible properties, there is therefore an option value to delaying sale that is equivalent to an interest-free loan from the government. This acts as a brake on the transfer of housing assets from low to high value uses. Moreover, CGT discount arrangements add to these inefficiencies by causing tax clientele effects as investors chase properties offering the prospect of high capital gains. As the budget reforms permit future investors in new-builds to retain the 50% discount, this distortionary impact on new supply will remain.
Land Value Taxes, in contrast, are widely and internationally regarded as one of the fairest and most efficient taxes possible. There is a great deal to gain by placing them at the heart of the management of the housing system.
Summing Up
The current government’s apparent willingness to tackle difficult housing tax issues offers an opportunity to advance comprehensive reform. Feebates are not the ‘silver bullet’ that will solve all housing problems. But they offer the prospect of a fairer housing future, as well as efficiency gains that smooth the operation of housing markets and secure productivity gains from a more optimal allocation of housing resources.
Of course, stamp duty (and to a lesser extent existing land tax arrangements) is an important source of revenue for state governments, which they cannot be expected to simply forego in favour of a national levy. In a Federation where taxation powers and service provision are shared across levels of government, there has to be negotiation and co-operation across governments when it comes to tax reform. There is clearly a role for the Federal Government to assist in meeting the revenue shortfall that state governments would experience in a gradual transition to a feebate system. Since these transfers will do more to improve housing affordability than the billions of dollars spent on ‘piecemeal’ programs such as first homeowner grants, this should surely be achievable.
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